WASHINGTON A current and a former unit of E*Trade Financial Corporation will pay $2.5 million to settle charges that they ignored red flags and improperly sold billions of unregistered penny stock shares on behalf of customers, U.S. regulators said on Thursday.
The Securities and Exchange Commission said that E*Trade Securities and E*Trade Capital Markets, later re-named G1 Execution Services LLC, failed in their so-called "gatekeeper" role and sold the shares without properly ensuring they met the exemptions in the law that allow such shares to be sold to the public.
"We are pleased to have resolved this matter with the Commission and from a financial standpoint, this matter was previously reserved for," an E*Trade spokesman wrote in an e-mail. The settlement includes fines and the return of ill-gotten gains to customers.
E*TRADE Securities is still an E*TRADE subsidiary.
E*Trade sold its market-making unit, G1 Execution Services LLC, to Susquehanna International Group LLP earlier this year for about $75 million. As part of the deal, it agreed to allow Susquehanna to execute and collect commissions on 70 percent of stock orders from its customers for five years.
The SEC's case is part of an ongoing effort to crack down on the so-called "gate keepers" in the microcap marketplace, with the idea that they should be conducting due diligence and detecting red flags before a fraud can be perpetrated.
Gatekeepers can include brokers, auditors, attorneys and transfer agents.
Also Thursday, the SEC published a risk alert to remind brokerages of their obligations to vet sell orders from clients to ensure that the securities are registered or meet certain exemptions from registration.
"Broker-dealers serve an important gatekeeping function that helps prevent microcap fraud by taking measures to ensure that unregistered shares don’t reach the market if the registration rules aren’t being followed," said Andrew Ceresney, the director of the SEC’s Division of Enforcement.
"Many billions of unregistered shares passed through gates that E*Trade should have closed, and we will hold firms accountable when improper trading occurs on their watch," he said of the alleged violations, which the SEC said took place periodically from March 2007 to April 2011.
This is not the first time that E*Trade has faced regulatory issues with its trading units.
In 2013, the company disclosed that the Financial Industry Regulatory Authority was investigating whether E*Trade routed customer orders to its internal G1 Execution unit, in violation of best execution rules.
That investigation is still ongoing, FINRA confirmed.
(Reporting by Sarah N. Lynch in Washington, D.C. and by Jed Horowitz in New York; Editing by Doina Chiacu and Susan Heavey)